2025 (6) TMI 1052 - AT - Income Tax

Bogus LTCG - Denial of claim u/s 10(38) - use of information uploaded on the system by the DIT(Inv) - AO had quoted facts pertaining to various unrelated persons and made additions in the hands of the assessee. One of the materials that had been used by the ld. AO was the suspension order in the trading of scrips of M/s Kailash Auto Finance - CIT(A) has deleted the addition HELD THAT - The Hon Kolkata High Court in dealing with a similar case in PCIT vs Swati Bajaj 2022 (6) TMI 670 - CALCUTTA HIGH COURT held that it was very rare and difficult to get direct information or evidence with regard to meeting of minds of persons involved in the manipulative activities of price rigging and insider trading. Therefore a wholistic approach is needed and the test of preponderance of probabilities has to be applied. The High Court further held that even if the assessee s were not named in the report of the investigation wing once they made a claim for exemption they had to prove the genuineness of the transaction and the genuineness could not be proved only with reference to documents submitted by them but with reference to the fact that the steep rise in prices of penny stock companies which had no intrinsic value when the scrips were purchased by them were genuine and consequently they were entitled to claim LTCG on their transactions. The Court held that the onus upon the assessee under section 68 would not be discharged unless they had furnished this information. In this back ground the court held The assesses cannot be heard to say that their claim has to be examined only based upon the documents produced by them namely bank details the purchase/sell documents the details of the D-Mat Account etc. The assesses have lost sight of an important fact that when a claim is made for LTCG or STCL the onus is on the assessee to prove that credit worthiness of the companies whose shares the assessee has dealt with the genuineness of the price rise which is undoubtedly alarming that too within a short span of time . Thus we are of the opinion that in view of the assessee having been found to be trading in a scrip the price of which was manipulated by operators to give false gains to parties the assessee needs to justify the genuineness of the long term capital gain claimed by him by showing that the purchase of the scrip was a bonafide decision that it was not a one off foray to take advantage of a scam and that his transactions did not fall in the pattern associated with the scam. CIT(Appeals) has also placed reliance on the revocation order passed by SEBI on 21.09.2017 wherein 244 entities have been exonerated of the charge of manipulating the price of Ms Kailash Auto Ltd in violation of PFUTP rules to contend that SEBI has not found involvement of the concerned company in any unfair trade practices and allowed the trading of the same again on public portal. It is not clear from his order as to whether before relying on such order to arrive at the conclusions that he has he solicited any comments of the Assessing officer. Be that as it may we observe that the CIT(A) has failed to note that in the said order the SEBI has confirmed that the price of the said scrip was rigged by 5 entities against whom investigations would continue. We observe that before the CIT(A) the Assessee has submitted that the AO has made the addition without giving any opportunity to the assessee and without providing any material that has been brought on record in spite of the fact that the assessee had requested for the same in writing. Further the Assessee has also contended that he was not allowed to cross examine witnesses whose statements were being used against him. We also observe that the AO has rejected the various documents submitted by the assessee without doing any independent inquiry to determine whether the trading done by the assessee actually fits into the pattern that is associated with the scheme outlined by him in his report. Therefore we feel it is appropriate to restore this matter back to the file of the assessing officer so that orders of the SEBI passed on 21.09.2017 and 5.12.2018 can be considered and so that the Ld AO may provide the Assessee with all the evidence on which he wishes to rely so as to enable the assessee to respond to the allegations levelled against him. Appeal is held to be allowed for statistical purposes.

Summary

Issues Presented and Considered

1. Whether the addition of Rs. 60,39,795/- made by the Assessing Officer (AO) on account of alleged bogus Long Term Capital Gains (LTCG) arising from the sale of shares in a penny stock company, was justified or whether the exemption claimed under section 10(38) of the Income Tax Act, 1961 was rightly allowed by the Commissioner of Income Tax (Appeals) [CIT(A)].

2. Whether the CIT(A) erred in deleting the addition without appreciating the organized modus operandi of tax evasion involving accommodation entries in penny stocks, as highlighted in CBDT Circular No. 23/2019 and subsequent Office Memorandum (O.M.) dated 16.09.2019.

3. Whether the delay in filing the Departmental appeal beyond the prescribed time limit was liable to be condoned in view of the special CBDT instructions exempting monetary limits for appeals involving organized tax evasion through bogus LTCG claims.

4. Whether the AO's reliance on statements of an entry operator and SEBI's findings on price manipulation of the concerned scrip sufficed to disallow the exemption claimed by the assessee without providing adequate opportunity to the assessee to rebut the allegations and cross-examine witnesses.

5. Whether the CIT(A) was justified in deleting the addition relying on the absence of specific adverse material against the assessee and the revocation order passed by SEBI, without considering subsequent SEBI orders confirming manipulation by certain entities linked to the scrip.

Issue-wise Detailed Analysis

Delay in Filing Departmental Appeal

The Department's appeal was filed beyond the prescribed limitation period. The delay was explained by the Department on account of the initial embargo imposed by CBDT Instruction No. 03/2018, which prescribed monetary limits for filing appeals, below which appeals were not to be filed. Subsequently, CBDT Circular No. 23/2019 and O.M. dated 16.09.2019 lifted the embargo for cases involving organized tax evasion through bogus LTCG claims in penny stocks, allowing appeals to be filed on merits regardless of monetary limits.

The Court observed that the period until 16.09.2019 ought to be excluded from the limitation computation since the Department could not proceed without express CBDT authorization. Considering the time required for communication and preparation, a delay until end November 2019 was reasonable. The Department's contention that time constraints due to time-barring assessments prevented earlier filing was accepted as a valid ground, not amounting to negligence.

The Court relied on the Supreme Court precedent that delay is not presumed to be mala fide or negligent and that condonation of delay promotes justice by enabling hearing on merits rather than dismissal on technical grounds. Accordingly, the delay in filing the appeal was condoned and the appeal admitted.

Validity of Addition on Account of Bogus LTCG

The AO disallowed the exemption under section 10(38) on the ground that the LTCG claimed arose from manipulation of share prices of a penny stock company, Kailash Auto Finance Limited, which was identified in a Directorate of Income Tax (Investigation) report as a vehicle for bogus capital gains. The AO relied on the statement of an entry operator, who admitted providing accommodation entries and manipulating prices to generate bogus LTCG/STCG/STCL through the scrip. The AO also referred to SEBI's interim orders suspending trading in the scrip and reducing price bands, and concluded that the assessee was part of a colorable device aimed at introducing unaccounted money as exempt LTCG income.

Further, the AO added a sum representing commission paid to the entry operator, based on his statements.

The assessee contested the addition before the CIT(A), placing on record purchase bills, demat account details, contract notes from SEBI-registered brokers, payment of securities transaction tax (STT), and other relevant documents. The assessee argued that these documents discharged the onus under section 68 to prove the genuineness of transactions and that no specific evidence was brought against the assessee to establish collusion or manipulation. The assessee cited multiple judicial precedents supporting the principle that mere suspicion or reports without specific proof cannot justify additions.

The CIT(A) noted that the AO had not conducted independent inquiries with the brokers or the company, nor had he examined witnesses or cross-verified the documents submitted. The CIT(A) observed that the Investigation Wing's report did not mention the assessee or the assessee's brokers specifically. He further noted that SEBI had revoked its interim suspension order against the scrip, indicating no prima facie finding of unfair trade practices against the company. The CIT(A) held that the AO's reliance on generalized reports and statements against unrelated persons was insufficient to sustain the addition. The CIT(A) relied on Tribunal and High Court decisions holding that documentary evidence of genuine transactions cannot be disregarded merely on suspicion or generalized reports.

The Department challenged this order before the Appellate Tribunal, contending that the CIT(A) erred in requiring specific investigation or evidence against the assessee and in relying on the SEBI revocation order. The Department submitted that once it was established that the scrip's price was manipulated by a cartel of traders and accommodation entry providers, the LTCG arising therefrom could not be treated as genuine, and the assessee bore the burden to prove genuineness beyond mere documentary evidence.

The Tribunal examined the issue in light of the AO's findings, the CIT(A)'s order, and relevant judicial precedents. It noted that the AO had brought substantial material including the entry operator's statement and investigation reports demonstrating a scheme of price rigging and bogus capital gains generation involving the scrip. The Tribunal distinguished the precedents relied upon by the CIT(A), observing that those cases did not involve detailed investigation reports revealing manipulation by a cartel, as in the present case.

The Tribunal referred to a recent High Court judgment holding that in cases of penny stock manipulation, the assessee claiming exemption on LTCG must discharge a higher burden of proof than in ordinary cases. The genuineness of the transaction cannot be established solely by production of purchase bills, demat account statements, contract notes, and STT payment receipts. The steep and sudden rise in prices of penny stocks with no intrinsic value must be examined holistically, applying the test of preponderance of probabilities. The assessee must prove that the purchase was bona fide, not a one-time foray to exploit a scam, and that transactions do not fit the pattern of manipulation.

The Tribunal also scrutinized the CIT(A)'s reliance on SEBI's revocation order dated 21.09.2017, noting that the order exonerated 244 entities but confirmed ongoing investigations against others. The Tribunal highlighted that subsequent to the CIT(A)'s order, SEBI passed a final order dated 05.12.2018 confirming price manipulation by seven entities linked to the scrip and debarred them from trading for four years. These findings were significant and had not been considered by either the AO or the CIT(A). The Tribunal opined that these SEBI orders must be taken into account and the matter required re-examination.

Regarding procedural fairness, the Tribunal observed that the AO had not provided the assessee with an opportunity to cross-examine witnesses or to respond to all material relied upon. The AO had rejected the assessee's documents without independent inquiry or verification against the pattern of the scam. The Tribunal held that these procedural lapses warranted restoration of the matter to the AO to provide the assessee with full opportunity to respond and to consider the SEBI orders comprehensively.

Significant Holdings

"The period upto 16.09.2019 ought to be excluded in view of the fact that the Departmental authorities could not have proceeded with the appeal in the absence of express authorization from the CBDT."

"Ordinarily a litigant does not stand to benefit by resorting to delay and there is no presumption that the delay is caused by mala fide or negligence... refusing to condone the delay can result in a good matter being thrown out at the outset, thereby defeating the cause of justice."

"The decision of the Constitution Bench of the Hon'ble Supreme Court in the case of McDowell and Co. Limited vs. CTO is squarely applicable to the facts of the case as the assessee was indulging in a colourable device and such colourable devices could not be a legitimate part of tax planning."

"Where overwhelming documentary evidences had been produced by the assessee, the burden shifts upon the ld. AO to explain them away and only the report of the Investigation Wing cannot be relied upon by the ld. AO to make the addition."

"Once such evidence has been brought on record to show that the assessee was a beneficiary of a scheme to artificially create capital gains, then the assessee has to discharge a far greater burden than what would be required in a normal case."

"The onus upon the assessee under section 68 would not be discharged unless they had furnished information proving the creditworthiness of the companies whose shares the assessee has dealt with and the genuineness of the price rise."

"The AO has rejected the various documents submitted by the assessee without doing any independent inquiry... the matter ought to be considered in the light of these findings of the market regulator in both its orders dated 21.09.2017 and 5.12.2018."

"The appeal is held to be allowed for statistical purposes."

Core Principles Established

1. Delay in filing Departmental appeals beyond monetary limits prescribed by CBDT Circulars may be condoned if the delay is attributable to the absence of prior authorization and other valid reasons, promoting adjudication on merits.

2. In cases involving alleged manipulation of penny stock prices to generate bogus LTCG, the assessee bears a heavier burden to prove genuineness beyond mere documentary evidence of share transactions.

3. Reliance solely on reports of investigation agencies without independent inquiry and without providing opportunity to the assessee to rebut and cross-examine witnesses is insufficient to sustain additions.

4. Findings of market regulators such as SEBI, including revocation or confirmation of manipulation orders, are material and must be considered by tax authorities before concluding on the genuineness of capital gains.

5. Restoration of the matter to the AO for fresh consideration and providing the assessee with full opportunity to respond is appropriate where procedural lapses and incomplete consideration of evidence are apparent.

Final Determinations on Each Issue

1. The delay in filing the Departmental appeal was condoned as the Department acted in good faith following CBDT instructions and due to operational constraints.

2. The addition made by the AO on account of alleged bogus LTCG was not sustained outright; however, the matter was remanded to the AO for fresh adjudication considering SEBI's subsequent findings and after providing the assessee with adequate opportunity to respond to all material evidence.

3. The CIT(A)'s deletion of the addition was set aside due to incomplete consideration of relevant SEBI orders and failure to address procedural fairness.

4. The appeal was allowed for statistical purposes, effectively restoring the assessment order for reconsideration in line with the directions given.